Many of you probably faced the unpleasant reception of an alert in December from a mutual fund you owned that reported capital gains during the year. That means you face capital gains taxes.
But your worries may soon disappear. More than 70 mutual funds have converted to exchange-traded funds since the beginning of 2021, according to Morningstar Direct. And that includes about 35 so far this year.
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“There are several reasons behind this trend,” according to a Loyalty Investment Report. “Near the top of the list: Investors generally love ETFs, and increasing fund flows into ETFs are proof of that.”
Therefore, “in the case of most mutual funds that have converted to an ETF, the fund company expected to attract more investors to the ETF compared to the mutual fund,” the report says.
“Another factor… is that the conversion fund retains its historical performance,” the report says. “This may be beneficial in attracting investors who prefer established funds whose historical performance can be evaluated.” Obviously, an ETF created from scratch has no track record of performance.
Impact on investors
So what does this mean for you? Of course, you'll get the benefits of being able to trade your ETF all day long, as opposed to just once a day (at the closing price) in the case of a mutual fund.
Probably most importantly, ETFs are structured to avoid capital gains taxes. The structure is complicated to explain, since these are actions in kind. Suffice it to say: Your tax bill should go down when you have an ETF instead of an actively managed mutual fund.
Here are three ETFs that have earned Morningstar's top Gold rating.
1. Invesco S&P 100 Equal Weight ETF (EQWL) – Get a free report. An equal-weight fund gives equal weighting to each of the stocks in the index. This contrasts with the regular S&P 100, in which stocks are weighted by their market capitalization.
2. iShares Core Aggressive Allocation ETF (AOA) – Get a free report. The fund tracks an index of stock and bond funds with an aggressive risk allocation strategy.
3. iShares Fallen Angels USD Bond ETF (FALN) – Get a free report. The fund tracks an index of high-yield corporate bonds that were previously rated investment grade.
